Thursday, July 12, 2012

Has the Chinese Apocalypse Started? Is China on the Cusp of a Deflationary Vortex?

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Note the publication date: Thursday, July 12, 2012

Update 5-26-2014
Is this article, written two years ago, finally pointing to reality... or a piece of reality? Here's a snippet from an article posted 5-25-2014.

China’s banking assets have grown to over 100% of its GDP in the last three years, according to Bass. If the U.S. had engaged in similar policies – which he said would translate to $17 trillion in lending over that time period – it, too, would have achieved more than 7% GDP growth.

China’s banking assets now total approximately $25 trillion, or almost three times the size of its $9 trillion economy. Its low default rate on bank loans – about 1% – is about to rise, according to Bass. Much of that lending is construction-related. Bass said that 55% of China’s GDP growth has been in the construction sector.

“A rolling loan gathers no loss,” Bass said, “and that’s what’s been going on in China for the last few years.”

Source: Kyle Bass On China's "Contraction" And "The Fed's Worst Nightmare"

Back to 2012

This is a follow up to the article I posted in Dec 2011:
Why China Will Collapse By This Summer (click the title to read the article).

While that article posed arguments for a collapse, the primary source was an expert, but an expert with a known bearish point of view towards China. I made some arguments, for the sake of two-sided discussion, against the collapse, but ultimately really never took a side and certainly, China did not collapse, not even close.

I'm going to reprise some of the arguments made in Dec with facts as of July (and with charts).

Let's start with premise in Dec and some snippets and bullet points to make it flow quickly. The source for this information comes from an interview with Gordan Chang on Yahoo!. You can listen to that interview here:
The Wheels Are Coming Off China’s Economy: Gordon Chang

Dec 20, 2011
Gordon Chang, author of "The Coming Collapse of China" and a columnist at, has been sounding the alarm bells about China for years and backs up his prognosis with recent government data:

-electricity consumption is flat
-car sales - a bellwether for consumption - are flat
-property prices are collapsing - even in cities like Shanghai and Beijing
-industrial orders are down - especially those relating to the domestic economy"

Point #1: It's not inflation to fear, but deflation
The Chinese government (and the world at large) has been vigilant if not obsessive about China’s rate of inflation. Most of the focus has been on keeping it from going too high as elevated inflation would prevent them from continually flooding the economy with money. But, the numbers reported by the Chinese government state that inflation fell from 5.5% in October down to 4.2% in November. Good right? Not quite. Chang claims that inflation dropping is a problem if it’s too fast – and he’s right. If those numbers are accurate – 1.3% in a month is almost preposterous. If repeated, that’s not a slowdown – that really is a collapse.

Point #2: Property values are plummeting
What does Mr. Chang mean by collapsing property values? According to him, property values fell by 30% in Shanghai and Beijing in the month of October, alone.

Point #3: Chinese provinces are in trouble -- pumping money in won't work
China’s fix (actually the entire world’s fix) for a potentially fledgling economy has been to pump money into the economy (see the US and Eurozone). But, there’s a problem with that now.

Gordon says China cannot pump more money into the system to stimulate growth because of "questionable bank loans" and the high number of local Chinese provinces in debt.

Point #4: They’ve already built their ghost cities
Chang drops a bomb with a statistic on Chinese M2. He claims that China’s M2 at the end of Nov was 34% larger than the United States’ even though the US economy is more than twice the size of China’s. In other words, there is money and liquidity – some could say, a glut of liquidity. In English, the liquidity that’s present isn’t getting used so adding more money won’t do anything. As Chang puts it, "They’ve already built their ghost cities."

There are several factors contributing to China's slowdown, and Europe certainly plays a big factor. Europe is China's largest trading partner and Chinese export orders in November dropped sharply from October, rising 13.8% last month from 15.9% in October. As reported by The Wall Street Journal, China's labor costs are no longer considered "cheap" as fewer migrant workers choose factory jobs, thus "pushing up labor costs."

"We'll see more obvious signs of deterioration in the Chinese economy over the next six months," says Chang.

Let's fast forward to the present. The two sources I make most use of are:
1. The last thing the world needs now is a deflationary shock from China. Source: The Telegraph, written by Ambrose Evans-Pritchard

2. China’s ‘5 apocalypses’ signal global recession. Source: Marketwatch, written by Paul B. Farrell

I'll source these throughout the article by referring to the source number (i.e. #1 or #2).

Here are the arguments that the stern warning in December was right:

Remember point #1 from Chang: It's not inflation to fear, but deflation
Source: #1
China is on the cusp of a deflationary vortex.

This was signalled late last year by the sharpest contraction in the (real) M1 money supply since modern records began. The hard data is now confirming the warnings.

(I've included a 5 year chart of Chinese M1; Source: Bloomberg (

China Monthly Money Supply ( 5years)

Consumer prices have been falling for the last three months, producer prices have been falling for four months. This is not a food cost story. It is systemic.

"While an economy-wide generalized deflation is yet to be seen, the deflationary spiral looks to have started in some industrial sectors, attesting to considerable stress with the economy. Persistent deflation can be poisonous," said Xianfang Ren from IHS Global Insight in Beijing.

China CPI (Jan 2011 - present)
Source: Trading Economics (

Indeed it can be poisonous, and China already has the twin-afflictions of the deflation malaise: a fast aging nation, and a surfeit of factories and industrial plant.

Source: #2
Five months ago, we quoted World Bank President Robert Zoellick’s warning of “a spreading crisis” in China that could consume the $75 trillion global economy. Back then we bluntly asked: “China? Or America? Who will crash the global economy first?” Think: China.

China’s economy of 1.3 billion people continues slowing, according to the latest GDP-forecast downgrade from Premier Wen Jiabao, reported Keith Bradsher of the New York Times.

“China might already be in recession,” warns Trefor Moss in his brilliant “5 Signs of the Chinese Economic Apocalypse” in the journal Foreign Policy. Actually, five huge apocalypses. “The numbers show that the country’s storied growth engine has slipped out of gear. Businesses are taking fewer loans. Manufacturing output has tanked. Interest rates have unexpectedly been cut. Imports are flat. GDP growth projections are down.” Wen Jiabao’s 2012 growth target at 7.5%, if it happens, “would be China’s lowest annual growth rate since 1990.”


Export growth is also slowing — to Europe and the U.S., as well as Brazil. In fact, “exporters are going bust, and some factories that remain open have switched from three shifts to just one.” Meanwhile, migrant workers are creating “mass incidents” that could explode into an inland version of Tiananmen Square as China, as a developed nation, finds its growth rate gradually slowing. Think: Arab Spring, Occupy Wall Street, Greek riots.

Obviously the Chinese are having real problems blending central planning with free-market capitalism in a global marketplace with everybody competing for the same scarce resources. China’s learning these lessons the hard way. The price of coal has dropped 10% in the past year. “This drop could further dent the global economy,” cooling demand for exports.

Remember Point #2: Property values are plummeting
Source: #2
China’s central government decided to cool the overheated real-estate market. Property sales and revenue then dropped, creating a shortage of cash and confidence among potential buyers. Sounds familiar? Like here in America, where government revenues declined with taxpayers’ and investors’ income and spending? Yes, China’s economy is slowing. China, in fact, is most likely in a recession. And exporting it to America.

Source: #1
The problem was the explosive growth of credit in the preceding years. China was no slouch in this area. The IMF’s Zhu Min says loans doubled to almost 200pc of GDP between 2006 and 2011, including off-books lending.

This is roughly twice the intensity of credit growth – around 50 percentage points of GDP – before the US and Japanese blow-offs.

There seems to a near universal assumption that China can pull the levers of the state banking system and set off a fresh credit boom whenever it wants.

Well, perhaps, but loan demand has withered. The big four banks lent just 190bn yuan in June, down from 253bn in May.

"Large banks are all offering money, but no one is taking it," said a Shanghai dealer quoted by Reuters. This is more or less what happened in Japan in the 1990s, what is happening in Europe now. It is what happened to half the world in the 1930s.

Remember Point #3: Chinese provinces are in trouble -- pumping money in won't work
Source: #2
Warning: China’s local governments drowning in debt
Remember the hundreds of billions of dollars that went to U.S. banks? Well, the China central government gave a $586 billion stimulus package to local governments.

Back in the boom days, many of China’s local governments went wild, like pension funds in America, and bought fleets of “flashy cars.” But now, for example, “the city of Wenzhou is planning to auction off 80% of its vehicles this year,” reports Moss. “That’s 1,300 cars, with similar fire sales occurring nationwide.”

Remember Point #4: They’ve already built their ghost cities
Source: #1
Macao’s casino revenue – that closely watched proxy for the Chinese economy – dropped 11pc in June. Commodity stockpiles are grinding ever higher, with coal depots bursting at Tianjin and other key ports.

Steelhome China Thermal Coal Inventory Tianjin Port (YTD)
Source: Bloomberg (

Steelhome China Thermal Coal Inventory Tianjin Port (5 Years)
Source: Bloomberg (

[A]t the end of the day, the country is bursting with industrial over-capacity. As Caixin reported recently, eight of the ten largest shipyards did not receive any new orders in the first five months of the year.

Source: #2
[...] China started importing to satisfy increasing energy demands. But now “China’s ports are piled high with coal that should be roaring in the country’s power plants.” Why? “Lower manufacturing output,” answers Moss. Last year planners were stockpiling emergency coal. Now demand is dropping as “hard-pressed citizens, businesses, and factories cut their electricity consumption in order to reduce their bills.”

More disturbing trends
Source: #2

Chinese billionaires don’t trust their government, so they’re “looking overseas to invest in high-end property,” creating a wave of wealthy Chinese seeking foreign residences. Why? Great deals. Versus too many local restrictions. And, notes Moss, as “a hedge against political and economic uncertainty at home.”

Moss reports that Chinese prosecutors have gone after 19,000 dirty officials since 2000: “China’s wealthy and politically powerful are often members of the same family, and if China really does go into recession, a lot of rich people may decide to cut and run.”

Earlier this week, MarketWatch’s Carla Mozee reported that China’s slowdown is already impacting stocks in Brazil, one of China’s leading trading partners. (Source: #2).

Albert Edwards from Societe Generale said the danger now is that China suddenly lurches into a deeper downturn, unleashing a flood of excess goods onto global markets and sending a powerful deflationary impulse across the world (Source: #1).

The bell ringing and hand waving in December about this Summer ultimately seems to be, at least in part, correct. There's no getting around it, China has new found problems and as the second largest economy in the world (and the fastest growing of the big boys), the balance of the global economic system may be in the balance. After all, who's going to come to the rescue? The EuroZone? Will that term even exist in five years? The United States? Really?...

This is scary stuff but there has been scary stuff written about China before... for a long time. Ultimately, I don't think anyone knows, and whoever ends up being right (between those that see this as a cataclysm and those that don't), in many ways, they may be right out of coincidence.

I will leave you with the final words from the article in Source #1:

"Woe betide the world if China does indeed land with a thud. We will then have a synchronised planetary slump for the first time since you know when."

This is trade analysis, not a recommendation.

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  1. Perceptive & well written - any thoughts for an update on this situation?

  2. Update... I think it's finally staring, but not at the cataclysmic level per Mr. Chang. But not good...